How Does Inflation Affect the Economy?

Affect of Inflation on Currency

Westernized countries have economies based on the value of the currency used to purchase goods. The economic system of the country relies on the value of the money they use to stay the same. For example, imagine going to the store and purchasing a 1 dollar candy bar, only to have the clerk tell you the candy bar now costs 5 dollars. The candy bar hasn't gotten more expensive, your money is simply worth less. This is an extreme example of how inflation can affect the economy, but nonetheless demonstrates the importance of 1 dollar consistently holding the same monetary value. Typically, inflation occurs at a much more gradual, but still noticeable rate.

Currency and Economy

If the money you have becomes worth less, in terms of the goods and services you are able to purchase with it, you will need to rearrange your budget. However, the primary reason that inflation affects the economy so negatively is the loss of value. For example, you still have the same amount of actual currency, you are not making more or less money at your job or splurging for excessive, unnecessary items. Since it is worth less, you need to use more currency to purchase the same items you always have. The result is a snowball effect, because inflation affects your boss too, so the company cannot simply compensate you with additional currency to compensate for the loss of value.

Impact of Inflation on Economy

Inflation impacts the economy so significantly because economies are organized based on the value of currency, both within and outside of the country. Therefore, we negotiate all financial interactions based on the worth of our dollar to another country's currency. For example, America may pay a company in another country to manufacture items and pay their employees 10 dollars a week. While most Americans would scoff at that type of compensation, due to our currency having a higher value, this is acceptable to those receiving the payment. Following an extreme period of inflation without recovering to economic stability, America may need to pay these same workers 20 dollars a week to provide the same value that 10 dollars once did.